Into the Future: Analysis and Predictions of Cryptocurrency ｜8 Decimal Research
- As the first application of blockchain technology, Bitcoin has been the most popularly traded cryptocurrency since first introduced, comprising 54% of total cryptocurrency value.
- When considering an ICO project, you need to consider not only your own country’s laws but also that of each and every investor in your project. While significantly varying degrees of regulation add another layer of complexity, active market participants are moving from locations with heavy regulations to crypto-friendly zones.
- Financial services giants such as Fidelity and Goldman Sachs are both launching their crypto custody service platforms to cater for institutional investors’ increasing needs for trusted service providers in the crypto space. For example, Fidelity formed a new business entity called Fidelity Digital Asset Services to provide cryptocurrency custody for Bitcoin, Ethereum and other yet-to-be-named cryptocurrencies.
In the Past — What happened in the past 6 months?
As the first application of blockchain technology, Bitcoin has been the most popularly traded cryptocurrency since first introduced, comprising 54% of total cryptocurrency value, see figure 1. In some sense, the popularity and value of Bitcoin trading is a fair indicator of the size of cryptocurrency market and liquidity. After reaching its historical high of nearly $20,000 per Bitcoin in December 2017, Bitcoin has stabilized around $5,000 — $7,000 in the past couple months. With the slowing interest growth from investors and increasing electricity consumption, the realized volatility of Bitcoin has fallen to the lowest level since the start of 2017, see figure 2.
Not surprisingly, ICO (a rough equivalent to the IPO in the mainstream investment world) is still active but moving slowly to unregulated or more crypto-friendly geographical areas. To address the needs for market participants for more stable and flexible investment opportunities in the cryptocurrency space, stable value tokens were designed to minimize price volatility by pegging its value to fiat currencies or to exchange traded commodities (such as gold, silver or other precious metals). However, not all stablecoins will survive, only the ones with low transaction costs, high liquidity and a defined regulatory structure will increase their adoption in the market.
Current trends — What’s happening after the hype?
With the rise of cryptocurrencies, one of the applications is the ICO. Startups and companies that are looking for additional capital to fund their business now have a new place to go. With fewer regulatory requirements and a lack of thorough due diligence, companies can simply create a white paper stating the basis of the business and the funds needed to undertake the venture to raise millions of dollars. This provides easier access to fundraising and investment opportunities for companies and investors, respectively. Similar to stock investors, investors who invest in these ICO projects are motivated by an expected return on their investments with the hope that these projects will work out as planned. In 2017, there were 435 successful ICOs, raising a total of $5.6 billion, with the 10 largest projects raising 25% of this total. In the first quarter of 2018, ICOs brought in $6.3 billion in funds, already outpacing the entire 2017 total with just 59% as many ICO projects, see figure 3.
For those who argue that ICOs are a new mechanism for better capital allocation, the high project failure rate should also be noted. In 2017 alone, approximately 64% of potential ICOs failed before or after their ICOs. The failure rate is even higher than that seen among startups in the first year, yet very little protection was provided for ICO investors due to the lack of regulatory and government oversight, see figure 4.
While this has scared away many retail investors from cryptocurrencies followed by the rapid drop in Bitcoin value in the beginning of 2018, more institutional investors are looking at cryptocurrency as an emerging asset class. As shown in Figure 5 below, CryptoFundResearch estimated that cryptocurrency fund AUM reached $7.11bn allocating among hedge fund (48%), venture capital (48%) and private equity (3%) and there will be 220 cryptocurrency funds created by the end of 2018. Financial services giants such as Fidelity and Goldman Sachs are both launching their crypto custody service platforms to cater for institutional investors’ increasing needs for trusted service providers in the crypto space. For example, Fidelity formed a new business entity called Fidelity Digital Asset Services to provide cryptocurrency custody for Bitcoin, ethereum and other yet-to-be-named cryptocurrencies.
Despite many new initiatives taking place at the institutional level, we still see many obstacles preventing large-scale investment in the cryptocurrency space and mass adoption of blockchain technology. Three of the major obstacles according to Morgan Stanley’s report are:
- Underdeveloped regulation so asset managers don’t want to take on the reputational risk
- Lack of a custodian solution to hold the cryptocurrency and private keys
- Lack of large financial institutions and asset managers currently invested
Into the Future — Opportunities and Threats
When looking into the future in the cryptocurrency and blockchain space, 8 Decimal Capital believes that certain areas will experience more success, namely security tokens.
- Security tokens — Whether or not a crypto token passes the Howey Test is the major difference between security tokens and utility tokens. Deriving their value from external and tradable assets, security tokens are subject to federal securities and regulations, see figure 6.
- Security token offerings (STOs) are providing investors a new form of ICOs that issue security tokens or asset-backed IOUs for providing investors with “access to shares of a company, a monthly dividend or a voice in the business decision-making process”. As shown in figure 7, four major traditional asset classes can be tokenized.
The use case of security tokens can even go beyond the above areas. Everything from company ownership to precious metals, currency, art, and sports teams can be tokenized. This is likely to reshape how investors manage their assets going forward. Security tokens can provide a wide range of benefits, including increased liquidity, 24/7 markets, lower transaction costs, fractional ownership, automated compliance, quicker settlement and a broader slate of possibilities with smart security contracts. And, in turn, realization of such benefits would pave the way for security tokens to have a banner year in 2019.
Despite the bright outlook for blockchain adoption and cryptocurrencies, regulations and government sentiment are something we should always be watching out for given the important role government and regulatory bodies play in this space. Regulatory and legal compliance is never simple, but it becomes even more complicated in the case of multi-national, borderless investing such as ICOs or cryptocurrency trading. When considering an ICO project, you need to consider not only your own country’s laws but also that of each and every investor in your project. While significantly varying degrees of regulation add another layer of complexity, active market participants are moving from locations with heavy regulations to crypto-friendly zones.
With a population of less than half a million, Malta is described as EU’s crypto leader due to its favorable and detailed legislation. In addition to no tax on foreign-sourced capital gains, Malta Digital Innovation Authority created by the local government is looking to provide a comprehensive framework for crypto businesses. Binance, the largest crypto exchange by volume, has recently announced that it will relocate its headquarters to Malta, see figure 8.
Meanwhile, citing from research firm Diar, U.S. government agencies have collectively spent $5.7 million hiring contractors who perform blockchain analysis, which involves linking an individual’s identity with their cryptocurrency funds. Unsurprisingly, the top spender within the U.S. government is the Internal Revenue Service (IRS), which has signed contracts with cryptocurrency forensic providers, together worth just under $2.2 million aiming to collect tax from these crypto activities. Meanwhile, the SEC, which regulates the securities markets and has filed charges against a variety of cryptocurrency fraudsters and initial coin offering (ICO) operators, has spent less than $185,000 on tracing the flow of funds.
Many banks are skeptical about Bitcoin and blockchain, yet some see Bitcoin, cryptocurrencies and blockchain as secret weapons to manage both macro and micro risks amid the rise of regulation and increased competition from non-banks. Even though a lot of money is being poured into blockchain technology and cryptocurrencies to help banks keep up with the technological developments, mass adoption is not as easy as many are still waiting to see where regulators fall.
The article is a research report from 8 Decimal Capital, a top blockchain VC.